Are Federal Student Loans Still the Best Choice?

Written by: Tyler Disburg of Credit Union Student Choice

In light of recent legislation discussions, rate changes and headlines flooding the media, I get this question a lot. Federal student loans have long been considered the “gold standard” for education financing, but is that distinction deserved today? The short answer is yes, but why? First, we should examine why federal loans inherited their “King of the Hill” status.

Federal loans have a history of borrower benefits

Since its inception in 1965, the federal student loan program has been designed to maximize access to higher education. Loans were created with borrowers in mind, offering attractive terms including “in school deferment” which gave students the ability to start paying down college debt after graduation. Further, loans were also made prudently with schools verifying enrollment, academic progress, and a realistic estimate of education expenses.

The list of historic borrower benefits made federal student loans an attractive option for borrowers, and for good reason. Benefits include:

payment deferment

ease of access

fixed interest rates

no credit requirements

no co-borrower requirements

extended forbearance

income based repayment

loan forgiveness

Ultimately, it is this list of benefits that make federal loans the “best” option for students.

If federal loans are so attractive, why are there alternatives?

As attractive as federal loans are, they no longer cover the entire cost of higher education. In fact, an Expected Family Contribution (or “EFC”) was developed to help define a portion of education expenses that would likely be covered by a student’s family. While the government expects a contribution from family, I think it is important to mention that the contribution does not have to come in the form of cold hard cash. A family’s contribution can come in the form of a warm meal, hot shower and even mom’s old Honda Civic. These all lower a student’s need to borrow for everyday needs and can significantly lower their long-term college debt.

Over the last few decades, college expenses have increased at a rate much higher than expected and federal aid has remained relatively constant. That means while a student may qualify for every dollar of aid available from the federal government ANDutilize family resources, they may still find themselves in need of extra money to cover expenses. This is commonly referred to as a funding gap and most students are faced with the challenge of responsibly filling that gap in order to attend college.

Filling the College Funding Gap

Private Student Loans fast became a convenient way to help with a family’s contribution in addition to any remaining gap in funding. Keep in mind, private student loans were not made to expand access to higher education for public benefit; for the for-profit lenders of the world, they were made to maximize shareholder wealth. This doesn’t mean private student loans or their originators are bad, it means they are in business not public policy. Check out the government’s Student Aid website for a great comparison of federal vs private loans.

In order to minimize the substantial risk associated with this type of loan, lenders by and large use different criteria than the federal loan program including:

variable rates

co-borrower requirements

tighter credit requirements

no loan forgiveness

All of this contributed to making federal student loans, the de facto best deal in education finance.

Is a private student loan the right choice?

Unfortunately as witnessed in other markets, the profit-driven private student lenders did not always follow industry best practices including verifying enrollment and associated costs, which lead to many borrowers accepting inferior loan terms. If you’ve ever heard someone complain about private student loans, this is probably why.

Fast forward to today and enter credit unions. Many private lenders have learned from the mistakes of the past. More private student lending organizations are using certification mechanisms (which means verifying how much you need with the school first) and educating borrowers about the true cost of student loans. Most notably credit unions have stepped up to help their members in a very real way. Credit unions are not-for-profit financial institutions owned by their members – not profit-driven shareholders. By leveraging that not-for-profit structure, credit unions are providing innovative solutions (even industry firsts) that:

are designed for students with their best interest in mind

finance college at a reasonable cost

educate borrowers about responsible borrowing and their finances

Credit unions have proven that lenders can be both responsible and meet their financial goals in order to help borrowers and their members achieve their dream of a college education without the high price tag often associated with private student loans.

With everything that’s happening, are federal loans really still the best option?

You may have heard that Congress in gridlock and federal loan rates set to double, and I just told you about credit unions offering excellent options, so you may be thinking, “do federal loans really deserve their best in class reputation?”

Yes.

First, a Congressional compromise now seems likely. Both the Senate and House are set to send legislation to the President that would drop student loan rates to their current rate or very close. However, the new rate will be variable based on Treasuries. This is a departure from the fixed rate past of the federal loan program. While these loans will have variable rates, the rate will be capped at a maximum rate substantially lower than most private options. Second, federal loans will still have full deferment, income based repayment, and loan forgiveness. These features arguably make a federal student loan the first place students should turn for education finance…even today. If you need to get started on your federal loan process, the first thing to do is the Free Application for Federal Student Aid (FAFSA).

Make a responsible choice.

Regardless of your financing decisions, I can’t stress enough how important it is to weigh your options and compare apples to apples. Make sure you look at the rates, fees and terms of the loan, but also the borrower benefits (like I mentioned above for the federal program). Responsibly paying for college is the best way to avoid any unnecessary long-term debt. Remember, a little hard work now is the key to making things much easier (and more affordable) in the future.